Debunking common myths about senior secured loans

Market Size Myth: “The loans market is niche”

Reality: The global SSL market is vast, with a diverse range of issuers across various industries, totaling $1.8 trillion.¹ The SSLs market offers broad, global diversification by industry and company, including global brands like Burger King, Dell, Hilton, Chrysler, and Formula 1.

Yield Myth: “Traditional bonds yield enough” 

Reality: SSLs generally can offer higher yields with minimal duration risk compared to traditional bonds.² This is because they provide a hedge against rising interest rates and inflation. They can also offer multiple layers of credit risk protection.³

Income Stability Myth: “Elevated income levels may not last” 

Reality: Compared to higher yield bonds which are typically unsecured, SSLs have consistently delivered higher levels of reliable income, even during market fluctuations. Between 1987 – 2020, the average debt recovery rate, as measured by ultimate recoveries for US SSL, was 80%, compared to 47% on average for US high yield bonds.⁴

As shown in the graph below, loan income comprises the base rate (dark blue bars), plus a credit spread (the light blue bars). As you can see, coupons rise and fall in lockstep with changes to base rates and, over the last 12 years, the total coupon has averaged about 5.5% p.a. in US dollars (the pink line).

Risk Myth: “Below investment grade is risky” 

Reality: Because SSLs are secured by assets and are positioned at the top of a company’s capital structure, they have the potential to mitigate risk effectively. This means that investors are effectively ranked first for any repayment in the event of a default by the issuer.

As the graph demonstrates, since 1998, loans have produced a very stable and upwardly sloping line. Downticks in loan valuations during the coronavirus pandemic were short-lived with very rapid and strong recoveries, which is testament to the senior secured status. 

Interest Rate Volatility Myth: “Uncertain times can be bad for loans”

Reality: SSLs have historically been insulated from interest rate volatility.

Figure 4 demonstrates that we have had uncertainty in the form of rate hikes and the possibility of a hard landing over the past 2+ years and loans have produced strong positive returns of 15.2% cumulative through this period with low volatility, benefiting greatly from the floating rate feature and senior secured status. In contrast, traditional bonds have produced negative returns and been highly volatile, with treasuries losing 15.3% and investment grade credit losing 8.4%, while high yield bonds have recovered recently to be +2.4% cumulative. SSLs can sometimes produce risk-adjusted returns because of their high coupon as rates remain stubbornly high. 

Borrower Fundamentals Myth: “Company fundamentals may be weak”

Reality: Borrower leverage has been declining, and interest coverage ratios remain positive.

Market Liquidity Myth: “The loan market is illiquid” 

Reality: The SSL market is highly liquid compared to private credit. SSLs are priced daily and offer daily liquidity. About half of the loans on issue trade each day, whereas for corporate bonds only 20% of issues trade on any given day.

The liquidity of the market allows for a number of daily liquid access methods including ETFs, daily liquid retail mutual and comingled institutional loans funds.

Risk Pricing Myth: “Markets price risk efficiently”

Reality: For a low-risk asset class, we believe the market consistently prices Senior Secured Loans incorrectly – and the data backs us up.

Over the 3, 5 and 10 year periods, loans have produced far superior risk-adjusted returns versus the fixed rate debt spectrum. 

Whether you consider risk as volatility, frequency of negative returns (only three in the last 32 years) or risk of permanent capital loss, senior secured loans have consistently provided a low-risk outcome over the last 30+ years.

Portfolio Fit Myth: “Loans do not fit in a diversified portfolio” 

Reality: Including SSLs in a portfolio has the potential to improve risk-adjusted returns. Loans are suitable for a core allocation within both diversified and income focused portfolios. Within diversified portfolios, loans are a complement to core bonds as a means of diversifying away from fixed rate assets like government bonds. We have demonstrated the consistency of income across all rate cycles and we expect that coupons will remain elevated above historical levels even after the rate cut cycle is complete.